Profit, Risk, and Overhead as it relates to rate negotiations

[foreng]

I am currently negotiating machine rates with our prime contractor and find myself at odds about an acceptable percentage for profit, risk and overhead.

Our industry (Forestry) works a little different then most in that, we sign long term agreements and guarantee a certain volume of work. The contractor is paid a unit rate ($/m3), that is derived by multiplying a machine rate ($/hr) to an negotiated production rate (m3/hr). The machine rates are based on a scheduled time (i.e. rate = (owning cost + operating costs/annual hours of use). An estimated overhead percentage (say 10%) and a profit/risk percentage (say 10%) are applied to the final negotiated unit rate. In my contractor's opinion the profit/risk value is low.
My first question is, how much risk the contractor incur when he is guaranteed a certain volume of work at a rate that reflects his minimum required annual hours of use? (i.e. If the contractor needs $X/hr to pay for his machine at say 2000 hours of annual use. The contractor has enough guaranteed work to easily make his 2000 hrs).

Next question is 1) How do profit and risk calculations compare in other industries? I know of some construction companies that would die for a contract that guarantees a volume of work over some time period. I also realize in some sectors the risk factor is high, lots of uncertainty. 2) Is a 10% profit reasonable when the risk level is low, would a value closer to 3-5 % be more reflective of a similar industry, say construction?

 

[dicksewerrat]

I see this as a time only contract. But you may want to look at some rental rates with operator for the same machine. I have seen extra work submittals that call for 15% overhead which includes office costs, insurance, financing, etc and 15% profit. So I don't think 10 and 10 is really out of line.

 

[KRSServices]

This is a question that has been dogging Owners since the contract was first developed. In my experience, i learned the hard way that the Engineer's interpretation of risk is vastly different than that of the contractor. I have not read the contract form, but would wager that there are some securities/bonds/insurance that are mandatory. There propbably are some indemnification clauses and likely some work related issues (environmental, public utility corridor, scheduling, reclamaaaaation) and a whole assortment of various "broad and sweeping" clauses prescribing the contractor's duties and responsibilities.

If the site is not fully known, which they never are, these unknowns are called risks to the contractor. For example, say an inclement weather claus exists where the contractor will not be remunerated for lost time due to inclement weather. If the duration is longer than he expects, there are real costs which he incurs, and in a negotiated contract such as this, would likely come directly out of profits.

To mitigate this, the Owner must be willing to take on or share in some of the risk.Long term contracts such as yours are great to have because it provides for guaranteed work/income, but an understanding of the risks relating to the final contract price in the final analysis will determine whether it's worthwhile or not.

Overhead and profit is a number which the contractor solely requests. His operation may be different than others and therefore his overhead may be higher/lower than a other contractors. Profit is a margin with which he wants to see, which, since it is an item for negotiation, is usually a point for differing opinions.

KRS Services

http://www.krs-services.com

 

[DRC1]

Another confusion is gross margin vs. net margin and net margin after taxes. Consultant billings include their overhead plus a markup. Contractor's billings do not include overhead. The Blue book includes an amount for shop, capitalization, depretiation, major over hauls and similar expenses. depending on how one costs equipment some ofthese items may or may not be considered overhead. Labor rarely has any overhead associated with it. To make a ong story short, a 15% markup for an average firm on labor and equipment would probably give you about 3-5% net after taxes. I don't care how much work you guareente, a 3-5% markup on labor & equipment, the contractor is probably not making any money and is reducing overall margin.
I personally would turn down the work.

 

[foreng]

Thanks for the advice, the overhead I'm referring to is general (i.e. office, admin, etc...) , the machine operating overhead is calculated in the rate. It sounds as though a 20% markup for general overhead and profit is acceptable as indicated above.

I have also just received a copy of the “American” Blue Book which has the ownership costs broken down in monthly, weekly, daily and hourly categories. They have identified the increased ownership cost associated with short term work (i.e. loss in productive hours). I can see why you are probably having some difficulty understanding my situation. Unfortunately in Canada our Blue Book has only hourly rates. When I speak of long term work I should be looking at the difference in ownership costs for longer work terms and leave the percent profit and general overhead alone. It really ties your hands when you only have hourly rates to work with. I also see the American Blue Book has a Canadian rate adjustment feature, you guy think of everything.